A123 Bankruptcy Casts Doubts on EV Goals

The theory was that the federal government could guide an entire US electric vehicle (EV) industry into existence by orchestrating a constellation of grants, loans and loan guarantees to manufacturers and infrastructure developers, along with generous tax credits for purchasers.  That vision was attractive, because EVs have the potential to be an important element of a long-term strategy to counter climate change and bolster energy security. However, yesterday's bankruptcy of battery-maker A123 Systems, Inc. provides a costly reality check. Along with the earlier bankruptcy of another advanced battery firm, Ener1, and disappointing battery-EV sales, it raises new doubts concerning both the government's model of industrial development and the achievability of President Obama's goal of putting one million EVs on the road by 2015. 

A123 was built around a novel lithium-ion battery technology developed at MIT.  For a time they were the darling of the advanced battery sector, with a market capitalization above $2 billion following its 2009 initial public offering. That IPO came on the heels of A123's receipt of a $249 million stimulus grant from the Department of Energy and $100 million of refundable tax credits from the state of Michigan. Subsequently, though, they experienced low sales and a costly battery recall that contributed to their signing a memorandum of understanding with China's Wanxiang Group to sell an 80% interest in the company for around $450 million.  Instead, it now appears that Johnson Controls, a diversified company that was the recipient of a $299 million DOE advanced battery grant of its own, will end up acquiring A123's assets for around $125 million.  Johnson is apparently providing "debtor-in-possession" financing for A123's Chapter 11 process.  It's not clear whether Johnson would be able to draw down the unused portion of A123's federal grant.

Because of the government's close involvement with A123, and in particular its structuring of aid to A123 in a manner that left taxpayers without any call on the firm's assets ahead of suitors like Johnson Controls or Wanxiang, this event is inherently political.  I was a little surprised it didn't come up in last night's presidential debate.  If it does become a "talking point" in the next two weeks, however, I'd prefer to see the conversation focus on the real issues it raises.  The reasons for A123's failure appear very different from those behind the much-discussed failure of loan-guarantee recipient Solyndra.  While the latter ultimately called into question the judgment of officials who loaned money to Solyndra when that company's business model was already doomed, A123 highlights the much deeper challenges involved in attempting to conjure an entire industry out of thin air.

The earlier failure of GM's electric vehicle effort in the 1990s, the EV-1, demonstrated the chicken-and-egg nature of EV sales: Vehicle sales depended on recharging infrastructure that in turn depended on robust vehicle sales to justify infrastructure investment.  But at least GM could begin then by relying on a mature lead-acid battery industry.  Those batteries turned out to be inadequate to meet consumers' expectations of range and recharging convenience, which led to the creation of another chicken-and-egg dependence for the new EV industry: carmakers needed a reliable supply of advanced batteries from producers who couldn't invest in the capacity to make them, without knowing that vehicle sales would consume enough batteries to turn a profit.  So in 2009 the administration set out to short-circuit all those inter-dependencies by simultaneously funding the key elements of these loops, including advanced battery makers.  It makes me wonder if anyone involved had any direct manufacturing experience--a natural doubt considering that the entire US auto industry was restructured in 2009 by a task force without a single member who had worked in any manufacturing business, let alone the auto industry. 

The main causes of A123's failure appear to have involved basic manufacturing issues of capacity utilization and quality control.  The company wasn't selling enough batteries to cover its costs, and too many of the batteries it sold came back in an expensive recall.  They weren't the first business to experience such growing pains, but their challenges were compounded by the burden of a manufacturing line that had been sized to meet the demand of an EV market that hasn't yet materialized. US EV sales through September amounted to just 31,000 vehicles, or less than 0.3% of total US car sales.  The picture looks even worse if you subtract out sales of GM's Volt and Toyota's plug-in version of its Prius, the gasoline engines of which provide essentially unlimited range, circumventing the limitations of today's batteries.  I think there's a strong argument that the government's assistance to A123 was actually a key factor in leading them to bankruptcy, by prompting A123 to grow much faster than could have been justified to its bankers or private investors.

Perhaps it's some consolation that A123's technology has apparently been snapped up by a competitor, rather than going the way of Solyndra's odd solar modules.  Yet that outcome hardly justifies the casual dismissal of A123's fate by a DOE spokesman as a common occurrence in an emerging industry.  That sort of talk merely perpetuates the perception of cluelessness fostered by Energy Secretary Chu's failure to hold anyone accountable for the Solyndra debacle.  Yes, companies in emerging industries fall by the wayside, but the preferred response would be to examine what happened and apply the lessons learned to the rest of the "venture capital portfolio" with which the administration's industrial policy has saddled the DOE.  With EV sales still low and several key EV makers experiencing delays and production problems, a thorough public review of the entire EV strategy is in order.

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How Green Is My Electric Vehicle?

One of the biggest challenges in assessing the environmental benefits of electric vehicles is that electricity is generated in so many different ways, with differing costs and consequences, and that patterns of generation vary by region, season, and time of day. As a result, categorical claims that EVs are always greener than the hybrids against which they compete most directly, or even compared to efficient non-hybrid compact gasoline or diesel-powered cars, must be suspect. The Union of Concerned Scientists (UCS) has just issued a report that takes some of the mystery out of such comparisons, including a helpful map showing likely greenhouse gas emissions associated with EV use expressed in terms of equivalent miles per gallon from a gasoline vehicle. The takeaway is that as of now, the emissions advantage of purchasing an EV depends heavily on where you live, with equivalent emissions from average grid power in many parts of the country about on a par with those from a small car like the Chevrolet Cruze, and not even as good as from a Prius-type non-plug-in hybrid.

This apparent paradox becomes clearer when you examine the cities map that the New York Times distilled from the report, reflecting the local basis of electricity generation. An EV operated in L.A. or San Francisco would unambiguously beat a Prius on emissions, while an EV in my neighborhood in Northern Virginia would have only a slight edge, and one in Denver would yield emissions comparable to an ordinary car getting 33 mpg, unless the owner was scrupulous about recharging only when greener power was available. That's because despite the declining share of coal-fired power in our national generation mix, there are still many regions and locales where coal dominates the grid, and the GHG emissions from coal-fired generation are considerably higher than from natural gas or low-emission nuclear and renewables.

Any report such as this must incorporate a number of assumptions, and from my fairly quick perusal of the details they seem generally well-identified here. The UCS's emission-equivalent miles per gallon calculation is based on a Nissan Leaf getting 3 miles per kilowatt-hour (kWh.) Grid emissions are calculated using a model of average hourly emissions over the course of the year. It didn't appear that these hourly-averaged figures were weighted for seasonal variations in driving patterns, but that's probably more nuance than is necessary at this level of scrutiny.

The report also includes information about recharging costs in different locations under different rate plans. Prospective EV buyers would benefit from taking the time to understand what these issues mean in their specific locations before investing in one. From my perspective, the report should also provide serious food for thought for policy makers concerning the wisdom of a single federal tax credit for EV purchasers in the US. As hard as that policy is to justify in the best of locations, based on the equivalent cost per ton of CO2 avoided, it looks positively senseless in locations where coal is still king. And while the report makes the point that the generation mix in many regions will become cleaner over time as utilities respond to renewable portfolio standards and other policies, buying an EV in a high-emissions region and counting on that factor to improve the car's environmental benefits during its lifetime seems like a risky bet, particularly in economic terms.

The biggest caveat I'd offer about the report concerns its emphasis on comparing EVs to non-hybrid compact cars, both on costs and emissions. That just doesn't seem realistic, given the array of choices and types of consumers in the market. While the number of consumers willing to consider an electric vehicle is increasing, the "take rate"--the number who actually convert their interest into a purchase decision, remains minuscule, resulting in sales of just 0.3% of all US cars sold in March. Meanwhile hybrids have benefited from rising gas prices to hit 3.4% of sales. It's also worth recalling that the fuel, emissions and dollar savings from improved fuel economy decline with each additional increment. Hybrids already capture the most valuable savings over conventional cars, while the incremental fuel savings from stepping up from a hybrid to an EV are roughly comparable to what hybrids achieve, but require additional battery capacity and electricity, neither of which is free. That makes hybrids the technology for EVs to beat. As helpful as the information provided in the UCS report should be for consumers, the ultimate decision to buy an EV seems driven more by values than value, at least until EV costs fall significantly.

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A Cleantech Trade War with China?

While we wait to see whether the next big move in oil prices--and hence gasoline prices--is up or down from today's level of around $125 per barrel, two stories in today's Wall St. Journal highlight some of the challenges facing manufacturers of equipment used to produce renewable energy. One concerns the intention of the US administration to seek the World Trade Organization's assistance in easing China's restrictions on its exports of rare earth materials used in a wide range of devices, including wind turbines, hybrid and electric vehicles, and some solar panels. The other is an op-ed offering a solution to the looming trade war over solar panel and wind turbine tower exports from China, modeled on the 1996 Information Technology Agreement that lowered trade barriers in that industry. The two stories are related, reflecting major unintended consequences of the ways we have approached our transition away from fossil fuels and toward lower-emission sources of energy.

Trade wars are risky things, because you never know where they will lead. The classic example of this is the Smoot-Hawley tariff of 1930. It and the responses to it by other countries helped deepen and extend the Great Depression, and I have never seen any analysis of them that concluded they were a good idea. A major trade dispute now over renewable energy hardware and the ingredients needed to produce it looks doubly unwelcome, because none of the parties comes to it with clean hands. Much of China's output of rare earths is being consumed by China-based manufacturers producing permanent magnet wind generators, electric vehicle motors, compact fluorescent lights, and solar equipment, much of which is exported to global markets that owe their very existence to government interference in the form of manufacturing, deployment and consumer tax credits; government loans and loan guarantees; feed-in tariffs; and fuel economy and lighting efficiency standards. There's hardly a single aspect of the global cleantech industry that is the result of unaided market forces.

The US complaint about solar imports is a good example. I wouldn't be surprised if the US government can make a strong case that the Chinese solar firms in question benefited from government assistance in ways that constitute unfair competition under established rules of international trade. Yet the same US government has provided substantial assistance to US solar manufacturers in the form of direct R&D support and federal loans and loan guarantees, as well as indirect help in the form of solar investment tax credits, cash grants, and project loans and loan guarantees that helped create and sustain a domestic market for them. All of these were necessary, because despite the significant cost reductions these incentives facilitated, the output of solar panels is still substantially more expensive than electricity from conventional generation. If we win this round with China, do we open the door to a whole series of WTO complaints against us by others who could claim harm from our own renewable energy policies?

From my perspective, these trade issues are a symptom of the larger problem of global overcapacity in wind and solar equipment manufacturing that has been created by the complex interaction of a mare's nest of national and local incentives and support for the production and deployment of these technologies, amplified by the disruption caused by the global financial crisis and recession of a couple of years ago and the ongoing financial crisis in Europe. A vast industry was created out of nothing and handed a market through a set of policies that could not sufficiently fine-tune development to prevent the emergence of a boom-bust cycle, and that now appears to be unsustainable itself in light of developed-country deficits and debts.

Trade disputes are one possible mechanism for attempting to rationalize this overcapacity, but in my view they constitute a much less productive approach than the one suggested by Professor Slaughter, who if I understand his proposal correctly is urging the rationalization of the government subsidies that have caused this situation in the first place. My biggest concern about his advice is his choice of the UN climate negotiating process as the best body to pursue such an initiative. That might be an appropriate venue, but its recent history doesn't inspire much confidence that it is up to the task.

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Administration's Tax Proposals Would Hamper US Energy Output

The Obama administration is proposing significant changes in US corporate taxes, as reported in today's Wall St. Journal. If enacted, the corporate tax rate would fall from 35% of income to 28%, although the elimination of numerous tax incentives would subject many companies, including most in the energy sector, to higher taxes overall. On the surface, this looks like the kind of tax reform that has been long overdue; however, as always with such efforts, the details matter enormously. In this case, the details would create an even less-level playing field for US energy producers, while doubling down on the expensive tax benefits currently provided to favored sectors and technologies. It's ironic that this is being proposed just when rising gasoline prices have put the administration on the defensive concerning its energy policies. It will do the President little good to point to increasing US oil production--demonstrably the result of energy prices and policies in previous administrations--if he simultaneously jeopardizes that recovery in output by making it less attractive to produce oil and gas here.

The basic principle of cutting marginal corporate tax rates in exchange for the elimination of "tax expenditures", or loopholes, in common parlance, is consistent with the much broader tax reform proposed by the fiscal commission established by the White House in 2010, even if the administration has opted for the upper end of the range of tax rates suggested by Simpson-Bowles. In general, US oil and gas companies wouldn't be worse off for losing the various deductions and tax credits in the current tax code, if the marginal tax rate were reduced sufficiently and if the administration weren't proposing to raise royalty rates on US onshore production by 50% at the same time. However, the combination of the proposed changes, including subjecting part of their non-US income to US taxation, would not only make US oil and gas projects less attractive, relative to projects in other countries; they would also make it less attractive to be a US oil and gas company, instead of a non-US company that operates here. For an administration that is concerned about US competitiveness, this is perverse logic, indeed.

It doesn't take a crystal ball to predict that the combination of higher corporate taxes on energy companies, higher royalties, and the more complex permitting processes instituted by the administration even before the Deepwater Horizon accident will make it much harder to sustain the recent recovery in US oil output beyond the completion of projects that were initiated during the previous administration. New oil and gas production would probably still be profitable here after these changes, particularly if oil prices remain as high as they are now, but company portfolios would begin to shift back towards non-US projects that look more rewarding by comparison, and US companies would lose some of their edge to non-US competitors. None of that would be good for US energy consumers, considering that the oil and gas industry accounts for 62% of the energy we use, including 49% of all energy produced domestically.

Of course, the administration's tax proposals reach well beyond oil and gas. Among other things, they would extend the Production Tax Credit for wind energy by another year, through 2013, as well as extending for another year the Treasury renewable energy cash grants that expired at the end of last year. After 2012, the cash grants would be replaced by refundable tax credits, which essentially means you'd get a check from the IRS, rather than from the Treasury, if the credit were larger than the taxes your firm owes. The net effect of the latter would perpetuate a costly system of renewable energy subsidies that reward the deployment of renewable energy hardware, rather than the actual generation of renewable energy. (That distinction is important whenever the hardware is installed somewhere lacking in good wind, sun, or other renewable resources.)

Then there's the proposal to boost the electric vehicle tax credit to a maximum of $10,000 per car, and to shift the recipient from the purchaser to the seller. That circumvents the problem that under the current $7,500 credit you'd have to earn enough income to be paying at least that much in federal income taxes, in order to enjoy the full benefit of the credit. However, it also makes it much likelier that manufacturers and dealers would pocket a significant slice of the higher credit, instead of consumers. Since it was nearly impossible to justify the $7,500 per car credit on the basis of actual oil or emissions savings, the higher credit looks even less justifiable, other than as a means of raising the odds of achieving the President's arbitrary target of putting a million EVs on the road by 2015--another near impossibility. The pluses I see here include an automatic phaseout based on time, rather than sales volume, and a broadening of the credit to cover other efficient vehicle technologies such as natural gas, though it's not clear whether it would also cover advanced diesels. Still, if the President has his way, we'll be spending more than $10 billion to put vehicles on the road that will save less than 35,000 barrels per day of oil, or about 0.4% of our total gasoline consumption, along with greenhouse gas emissions worth less than $1 billion at market prices--even European market prices.

The proposals include other provisions that would affect the energy sector, including tax benefits for advanced energy manufacturing such as wind turbines, solar panels, advanced batteries, electric vehicles, and an array of other equipment. I'd be much happier with those incentives if they were provided as an alternative to origin-blind deployment incentives, instead of alongside them. And although oil and gas companies would lose the manufacturing tax deduction on their US production, it appears they might get to keep that deduction on US refining, which has been hurt by higher oil prices. That would be small consolation to independent refining companies that have been forced to close several large east coast refineries or that are barely breaking even.

If President Obama is serious about tax reform, the current proposals--flawed as they are--would have carried a lot more weight had they been introduced a year ago, in the immediate aftermath of the Simpson-Bowles report and various other tax reform suggestions, rather than in an election year. And if he is truly serious about the"all-out, all-of-the-above strategy" for energy that he referenced in this year's State of the Union address, the current proposals look like an extremely odd way to execute that, favoring as heavily as they do sources that account for less than 2% of US energy production, while penalizing those that contribute nearly half. The good news is that this is a meal that won't be eaten hot. For now, this package serves as another plank in the reelection campaign platform. Whether it will ultimately be implemented depends not just on who occupies the White House after January 20, 2013, but also on the composition of the next Congress since it has no chance of passage in the 112th.

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Cleantech Firms Paying the Price for Subsidies

In observing the recent struggles of various segments of the global cleantech industry, including renewable energy and advanced energy technology firms, a pattern is emerging. Today's Wall St. Journal reports "Wind Power Firms on Edge," as the US wind industry hunkers down pending the renewal or expiration of a key subsidy at the end of 2012. A maker of electric-vehicle batteries that received a federal grant to build a factory in Indiana is reorganizing via bankruptcy, wiping out the equity of its original investors. Meanwhile, the US International Trade Commission may be on the verge of imposing retroactive tariffs on imported Chinese solar power equipment. Each of these stories has unique features, but what they share in common is the consequences of renewable energy policies around the world that promoted overcapacity in manufacturing and fierce competition in deployment, effectively setting up some of their past beneficiaries for failure or at least a period of very low margins. Depending on your perspective, this is either an indictment of such subsidies or collateral damage on our way to a brighter future.

One blogger from an advanced battery trade association noted that "Ener1 Is No Solyndra", and I tend to agree. As I've noted previously, the decision to award Solyndra a $535 million federal loan was ill-advised, not just because of competition from other solar manufacturers, but because at the time the government approved the loan the failure of Solyndra's business model was essentially already predetermined. Solyndra didn't contribute much to the global overcapacity in solar modules and panels, because its technology was never competitive. By contrast, Ener1's problems appear more fundamental. Like much of the global wind industry and solar industry, it was induced to invest in new capacity, the market for which depended almost entirely on subsidies and regulations that governments might not be able to sustain as these technologies scaled up, and that has gotten significantly ahead of demand.

The best examples of that are probably the various solar feed-in tariff (FIT) subsidies in Europe, which until recently were so generous that they not only supported the intended growth of an indigenous solar industry to capitalize on them, but also gave rise to an entirely unintended new export-oriented solar industry in Asia that had essentially no local market when it started, yet has since gone on to dominate global solar manufacturing and eat the lunch of the European solar makers and developers who got fat off the earlier stages of the FITs.

Or consider the US wind industry, including the imported equipment that still supplies around half of the US wind turbine value chain, according to the main US wind trade association. If the 2.2¢ per kilowatt-hour (kWh) Production Tax Credit (PTC) is renewed, and if wind generation grows from the current level of 115 billion kWh per year to 141 billion kWh by 2021, in line with the latest Department of Energy forecast, then over the next 10 years the wind industry would collect up to $30 B, with much of that locked in for projects that have already started up, less the amount generated by projects that opted for the expired Treasury cash grants in lieu of the PTC to the tune of $7.9 B from 2009-11. Yet based on these figures, wind would supply just 3.2% of US electricity in 2021. The industry now seems to be arguing that it needs just one more renewal of the PTC in order to become competitive. As of 2012, this benefit has been in place on an on-again, off-again basis for twenty years.

Although the theory that underpins such subsidies doubtless has some validity--that governments can help new technologies to develop quicker than markets alone would support, create markets for them by stimulating demand, and thereby move them down their learning curves to earlier competitiveness with conventional technologies--in practice such policies also have the serious shortcomings we are seeing. Because they do not operate in Soviet-style centrally planned economies, none of these governments can tell manufacturers precisely how much production capacity to build, or how much they will sell when it comes on-stream. In the absence of such powers--which in any case proved to be over-rated--companies and their investors are at the mercy of the boom-and-bust cycles such policies generate, with the normal, self-correcting mechanisms of industry consolidation dampened by continued intervention. Nor do the policies now in place seem very successful at creating industries that can survive without them. If you doubt that, ask the US wind industry for their forecast of new installations next year if the two-decade-old PTC is not renewed. According to the Journal, it would be somewhere between 0% and 30% of 2011's 6,810 MW, which was itself a third below the 2009 peak of 10,000 MW, despite the late-2010 extension of the cash grants to cover last year's projects.

The appropriate response to all of this depends on one's politics and the firmness of one's belief that these technologies are essential tools for combating climate change. Falling between the extremes of "just say no" and "look the other way" is the view that governments at least have an obligation to learn from the past and avoid the temptation to yield to demands that they leave existing subsidies in place until their beneficiaries decide they are done with them. If wind tax credits are extended, it should be at a level that recognizes the narrowing competitive gap with conventional energy and phases them out on a schedule. Electric vehicle subsidies should also be reassessed so that we don't find ourselves still providing upper-income taxpayers with incentives of $7,500 per car, even after sales have taken off and sticker prices fallen significantly. And solar subsidies ought to be fundamentally rethought to make it less attractive to install solar panels in regions with low sunlight, such as New York and New Jersey, than in those with abundant sun. And we shouldn't do that just for the benefit of taxpayers and in response to trillion-dollar budget deficits, but in the interest of producing healthy, globally competitive companies in these industries.

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D.C. Auto Show Focused on Efficiency

Last week I attended the media preview of the Washington Auto Show. With its dual focus on cars and energy policy, this is always a high point of the winter for me, even if this year's display lacked a draw of the magnitude of the pre-production Chevrolet Volt I drove at the 2010 show. Instead, I was pleased to find that the emphasis on fuel economy and technology in carmaker presentations was matched by a broad array of efficient and attractive new products. They still don't quite constitute the new car fleet needed for the 54 mile-per-gallon target the federal government requires them to meet by 2025, but in my opinion they're off to a very good start.

No one listening to the presentations I sat through last Thursday could have missed the shift in focus from previous years. Performance and drivability were still mentioned prominently, but in most cases the innovations allowing those attributes to be delivered along with improved fuel economy, instead of at its expense, received top billing. I heard about Ford's nine models that achieve at least 40 mpg, including the new C-MAX Energi plug-in hybrid that received Green Car Journal's Vision Award for 2012. GM touted a number of efficient new models, including the upcoming Chevrolet Spark subcompact, which will later be available as a full EV. In some respects I found the 2013 Malibu Eco with "e-Assist" even more impressive: With the new Malibu and this year's Buick LaCrosse, GM is building family-sized gasoline-powered sedans that achieve 36 or 37 mpg on the highway. And thanks to Fiat's MultiAir technology, Chrysler had its new 40 mpg Dodge Dart on display.

I was particularly interested in the VW press conference, where they debuted the 45 mpg 2013 Jetta turbo hybrid. The head of VW's US division introduced the car as part of his company's Think Blue sustainability drive, which with this latest model encompasses hybrids, clean diesels, efficient non-hybrid gasoline engines, and soon EVs. With all this technology to talk about, including the new, larger Passat sedan--where's the wagon?--built in VW's new Chattanooga, TN plant and sporting a diesel engine delivering 43 highway mpg (31 city), the biggest surprise was the amount of time he devoted to VW's partnership with Bikes Belong, a cycling safety group aimed at getting people out of their cars. That certainly reflects a bigger-picture view of vehicle sustainability.

My visit to the car show also included a meeting with Lars Ullrich, marketing director of Bosch Diesel Systems North America, and Jeff Breneman of the US Coalition for Advanced Diesel Cars. They updated me on the progress that diesels have been making in the US market, particularly in light of the greater cost-consciousness of consumers, post-recession. In the last five years, the willingness of consumers to consider diesels has nearly tripled to around one-third, while diesel sales passed the 100,000 mark for 2011--still less than 1%, but about where hybrids were just a few years ago. Clean diesel models are expected to double by 2014. Models with announced future diesel versions include the Chevrolet Cruze, Jeep Cherokee, Dodge Dakota, and a Mazda crossover. Will diesels ever reach the level of popularity here that they've attained in Europe, where half of all new cars are diesel-powered? They must wage an uphill battle against fuel economy regulations that are anything but fuel-neutral, legacy perceptions formed by the dirty diesels of 20 years ago, and federal and state fuel taxes that still assume that all diesel fuel is used by heavy-duty trucks that wear out our highways. That's a shame, because this is a terrific technology that could be every bit as attractive to many consumers as more expensive hybrids.

Another noteworthy item I gleaned from the manufacturers' presentations was that several of them are forecasting a return to annual US car sales of 16 million within a couple years. That would be good for the industry and employment, but it's crucial for shifting the fuel economy of the entire light-duty vehicle fleet. One of the unnoticed consequences of the low car sales of the last several years is that the US fleet has been aging faster, notwithstanding the small blip from the Cash-for-Clunkers program of 2009. The difference between sales of 16 million a yar versus 12 million is an average turnover of 15 years, instead of more than 20, and faster turnover should translate to quicker improvements in average mpg.

For years we heard that the biggest obstacle to improving the fuel economy of the US car fleet was the auto industry, which only wanted to sell us big SUVs that carried higher profit margins. That excuse was always overly simplistic, and it has been relegated to the ash heap by a new generation of cars and light trucks featuring innovations delivering steadily improving efficiency, even in mainstream sedans and SUVs. Getting the entire fleet to 54 mpg won't be easy, but if what I saw at the D.C. auto show is any indication, the attainment of that goal now depends at least as much on sales mix as on the availability of efficient models. Within a few years, virtually every segment of the market will include hybrid, diesel and EV options that will put a big dent in both fuel bills and emissions, albeit at the expense of higher sticker prices. That means that future fleet mpg will likely be determined mainly by the decisions of consumers, rather than carmakers.

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Breaking Our Oil Addiction

In an article in today's Washington Post an official of the National Wildlife Federation was quoted linking rejection of the Keystone XL pipeline with breaking our addiction to oil. Even with the administration apparently having delayed its decision on the project until 2013--quite possibly killing it--this point merits further exploration. Just how might we go about breaking that "addiction", and when could we reasonably expect the task to be accomplished? As with everything else to do with energy, the answers to those questions must be based on facts and figures, rather than wishfulness.

The brief quote and its context imply that a decision to forgo additional supplies of oil from Canada or any other source would, by itself, move us significantly closer to breaking our addiction to oil, a rather vague phrase brought into common usage by President Bush's 2006 State of the Union address. Of course if delaying or rejecting the pipeline only results in continued or additional oil imports from other countries, that would be counterproductive from an energy security standpoint, and perhaps even from an environmental perspective. Ending our oil addiction requires more than just a real or artificial supply constraint; it calls for enormous quantities of energy from other sources, mainly for transportation, along with significant improvements in the efficiency with which we use that energy. How soon should we expect such a transformation?

Start with electric vehicles, which are essentially the only pathway by which renewable electricity sources like wind, solar and geothermal power would have any impact on our oil consumption, because less than 1% of US electricity is now generated from oil. Even if EVs turn out to be the long-term solution to our transportation needs, as I suspect, it will be many years before they can displace enough fuel demand to make a dent in our oil addiction. The current goal is to have a million EVs on the road by 2015. As ambitious as that target seems compared to current sales of less expensive hybrid cars, that would constitute just 0.4% of the 238 million cars and light trucks in the US as of 2008. Moreover, even if EVs replaced cars of only average efficiency, one million of them would displace just 31,000 barrels per day of gasoline. In other words, it would take more than 20 million EVs to save the volume of oil that the Keystone Pipeline could have delivered annually.

If we want to kick our oil habit quicker than by waiting for a hundred million EVs to turn up, we'll need an energy source that's compatible with the vast majority of existing cars, and the ones like them that will probably dominate new car sales for some time. Consider ethanol, our largest and most successful alternative energy initiative so far. Through August, ethanol accounted for 9.2% of 2011 US gasoline consumption, nearly four times its contribution in 2005. However, before we could use a lot more ethanol in our cars, in the way Brazil has, we would need to overcome some big hurdles. Raising the proportion of ethanol in gasoline above 10% creates logistical and reliability problems, and the flexible fuel vehicles that can run on nearly pure ethanol are relatively scarce. In addition, we would need to produce most of the incremental ethanol from a feedstock other than corn. With the latest disappointing crop forecast from the US Department of Agriculture, ethanol production will consume about 41% of this year's harvest. Whether or not that's already enough to cause major food vs. fuel concerns, doubling corn use for ethanol would clearly push corn prices up drastically and cause ripple effects throughout the global food economy.

The good news is that biofuels--including better fuels than ethanol--can be produced from a wide variety of non-food crops, along with their efficient production from sugar cane in the tropics. The bad news is that with the exception of cane ethanol, none of these has been demonstrated on anything close to the scale required. Two of the largest cellulosic ethanol projects under construction, POET's Emmetsburg, Iowa project and the Vero Beach, FL facility of INEOS Bio, will together be capable of supplying just 0.02% of US vehicle fuel needs. And until these plants are up and running, their owners won't know whether their economics are sufficiently favorable--even with the current $1.01 per gallon cellulosic tax credit--to provide a basis for building more and larger versions. Although some of the many competing processes for producing biofuels from non-food biomass including wood, waste, dedicated energy crops and algae look very promising, they all face major uncertainties in development and scaling-up, including the scale-up of their supply chains, and none is yet ready for prime time. That might still be the case ten years from now.

Of course there are many other fuels we could put in our cars, after some modifications, including methanol, compressed natural gas (CNG), liquefied natural gas (LNG) or possibly even ammonia. However, the production of all of these, aside from a relatively small amount of landfill gas, is currently based on fossil natural gas, and all would require major investments in infrastructure and/or vehicle fleets. For that matter, 78% of the energy content of corn ethanol comes from natural gas and other fossil fuels--it also consumes enormous quantities of water--and most of the incremental electricity consumed by the first EVs will likely be generated from gas.

Although it appears that we have ample resources of natural gas to expand its use beyond current demand, I'm not sure that's quite what environmentalists have in mind when they talk about breaking our addiction to oil. And so far we've only considered alternatives to gasoline, without factoring in the significant demand for petroleum products for moving goods by truck, train and ship, along with aviation fuels, lubricants and many other products. Together, they account for as much oil as we use in cars, with non-oil alternatives for most of them at an earlier stage than for gasoline. And while energy efficiency measures, including the substantial improvements in vehicle fuel economy that are possible on a technology-neutral basis--including shifting cars to fuel-efficient diesels--can help to reduce the size of the mountain we must climb, they can't turn it into a valley.

Taking all these considerations into account it's not realistic to imagine that we could break our addiction to oil to any great extent for at least another decade. In the interim, we should certainly pursue all options that could alter the feasibility of such a shift in the years ahead, in a manner consistent with the fiscal constraints we face. I'm also not oblivious to what that implies for greenhouse gas emissions and climate change, though I would point out that our use of oil in transportation is neither the worst emissions offender, nor the easiest high-emitting segment of the US energy economy to tackle in that time frame. In the meantime, we are committed by virtue of scale, infrastructure and fleet requirements to burn many billions of barrels of oil over the next few decades, from wherever they may come. In that light, the administration's decision on the Keystone XL pipeline could prove to be a costly misstep, no matter how much political pressure they were under to withhold approval.

Addendum: Bloomberg has put out an interesting post-decision editorial suggesting that there's no reason for the review of an alternate pipeline route to take as long as the State Dept. has indicated.

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US Energy Poll Reveals Contradictions

Yesterday I received a press release announcing the results of a new poll on US consumer attitudes towards energy conducted by the McCombs School of Business at the University of Texas in Austin. I wasn't surprised to see that a plurality of the poll's respondents thinks the country is headed in the wrong direction on energy--triple the proportion that think we're on the right track--and many expect the situation to get worse in the next 25 years. That meshes with numerous readings on Americans' views of the overall economy. The poll also showed consumers broadly dissatisfied with the job that government and industry are doing in this regard, though the renewable energy sector, along with engineers, scientists and academia received somewhat better marks. At the same time, the results on several questions either contradict current consumer trends or reveal a poor understanding of energy market influences. Perhaps the most reassuring finding was that less than a quarter of consumers consider themselves knowledgeable on energy, while a large majority is interested in learning more.

The main question that grabbed my attention concerned consumers' "expectations for adopting new technology." 38% reported they were likely to use smart meter technology within the next five years, 30% said they were likely to own a hybrid car, and 21% were likely to install solar panels on their homes. On the face of it, these should be very encouraging results for the renewable energy and advanced vehicle sectors and those who invest in them. At the same time, it's hard to square these figures with the actual adoption rates for such technologies in the marketplace.

Consider hybrids, which have lost most of their novelty in the last decade, with cumulative US hybrid car sales standing at just over 2 million at this point. That's less than 1% of total US light-duty vehicles (cars, SUVs and light trucks), but it's still impressive, considering they started at essentially zero in the late 1990s. The problem is that even now, with practically every major carmaker offering at least one hybrid model, and several fielding an entire range of hybrids, 2011 sales have averaged just 2% of total US car sales of 9.5 million through September, based on figures compiled by hybridcars.com. Add plug-in electric cars like the Chevrolet Volt and Nissan Leaf and you get to 2.1%. Even before hybrid supplies were constrained in the aftermath of the earthquake in Japan, advanced vehicle sales never topped 3% in any month of this year.

The poll provides few insights into why the actual "take rate"would amount to less than a tenth of those with favorable attitudes towards buying a hybrid. However, it does suggest that the standard explanation that gas prices just aren't high enough yet is out of step with how consumers view those prices. Fully 95% of respondents described gas prices as either "very high" or "somewhat high", and 78% expected them to be somewhat or significantly higher in six months. One possible conclusion is that despite coming in compact, SUV, truck and luxury flavors, hybrid technology still doesn't deliver the value and/or performance most consumers are seeking, even if they're receptive to it in the abstract.

Then there's the even more dramatic disconnect on solar power. If 21% of single-family dwellings in the US were to install rooftop solar panels of 3 kW or more in the next five years, that would equate to at least 228 GW of solar power--about 90 times current US installed capacity--for average installations of 46 GW per year, or nearly three times the amount installed globally last year, mostly in Europe. As of the end of 2010, there were 153,000 grid-connected PV systems in the US, including commercial and utility installations. Even if all of them were on the rooftops of homes, that would still amount to just a 0.2% market penetration. Although PV prices are coming down rapidly and sales could approach 2 GW in 2011, this divergence between sentiment and sales suggests that a lot more Americans like the idea of rooftop solar than are actually willing to invest in buying (or leasing) it at this point.

Whatever the UT poll results indicate about the potential medium-term market share of new energy technologies, they provide a data point that Americans view energy as another important issue they believe government is getting wrong. They also highlight the need and opportunity for more education on how energy markets really work, with supply constraints and growing demand actually having a much bigger impact on energy prices than the limited pricing power most energy companies enjoy.

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The Next Big CAFE Loophole

The great pitfall of government policies, no matter how well-intended they might be, is their inevitable unintended consequences. When those are truly surprising, it's hard to attach much blame to the legislators or regulators involved. However, that degree of indulgence shouldn't apply when the unintended consequences are as obvious as the ones inherent in the new fuel economy regulations that were announced with such fanfare last week. After all, an earlier generation of CAFE standards gave rise to what might just be the classic unintended consequence of recent times: the "SUV loophole" that fed a 20-plus-year SUV fad and dug the nation's oil consumption hole much deeper than it needed to be, affecting oil prices, trade deficits and energy security. Now regulators are proposing the creation of a similar loophole for electric vehicles.

I'm not surprised that the coverage I have read on the latest CAFE debate didn't remind the public of the ongoing consequences of treating pick-up trucks and delivery vehicles differently than passenger cars when the first CAFE standards were established in the 1970s. (That loophole was mostly closed just a few years ago.) Who could have guessed that a provision intended to help small businesses would blow up, because an entire generation embraced deluxe versions of such vehicles as their primary transportation--by the tens of millions--undermining the purpose of the CAFE standards to reduce gasoline demand? When I looked at this several years ago, I estimated that SUVs had increased US gasoline consumption by over 400,000 barrels per day, or roughly 5% of total demand, equivalent to the energy contribution of around 10 billion gallons per year of ethanol.

In this case the problem starts with the evolution of Corporate Average Fuel Economy standards from a tool intended solely to improve US energy security by reducing the consumption of petroleum products in transportation, to one encompassing the greenhouse gas emissions implicated in climate change. Although there are important overlaps between these two goals--keeping a chorus of pundits employed touting them--they are not identical in operation or effect. Consider the specifics of the new CAFE proposal.

The "supplemental notice of intent" from the National Highway Traffic Safety Agency (NHTSA) of the Department of Energy, the body that along with the EPA designs and enforces the CAFE standard, spells out the special treatment accorded EVs in the rules that will be forthcoming. It states that EPA intends to give manufacturers multiple credit for each EV, plug-in hybrid (PHEV) and fuel cell vehicle they sell, starting at a multiplier of 2.0 for EVs and fuel cells and declining to 1.5 by 2021, as if these cars somehow canceled the emissions of more than one vehicle. They also intend to treat EVs and the electric portion of PHEVs as having zero emissions, regardless of how the power they use is generated. So in order to meet the tough greenhouse gas standards that accompany the 54.5 mpg CAFE standard, carmakers will have every incentive to produce as many EVs they can. Unfortunately, it's not obvious that this will reduce emissions in the real world, except in the rare instances when EVs recharge exclusively from renewable or nuclear power, which provide only 30% of our electricity mix today, up from 28% in 2005.

One needn't assume that EVs might be recharged using only coal-fired power to see that they aren't always a big improvement, emissions-wise, over non-plug-in Prius-type hybrids or clean diesels. Using the average US grid CO2 emissions of around 1.3 lb/kWh, a Nissan Leaf getting 3 miles per kWh is responsible for the emission of roughly 200 grams of CO2 per mile traveled. By comparison, a 2011 Prius with its 50 mpg EPA average emits around 196 g/mi. A more rigorous comparison would require a full well-to-wheels lifecycle assessment, but that is precisely what the new CAFE rules eschew in the interest of leaning on the scales to help today's preferred vehicle technology.

Subject to further refinement, this back-of-the-envelope analysis suggests that skewing the new CAFE regulations in favor of EVs isn't going to do much to reduce greenhouse gas emissions. Its main advantage is in reducing oil consumption, since less than 1% of our electricity is generated from oil. But if we only cared about oil and not emissions, producing gasoline from domestic coal--in the same manner as a sizeable fraction of South Africa's fuel supply--would be equally effective at backing out oil imports. Meanwhile, a gallon of gasoline saved by an advanced internal combustion engine with stop-start technology and other low-cost efficiency features would be worth exactly as much as a gallon saved by an EV, while costing dramatically less. That's especially true when you factor in the $7,500/car EV tax credit, which I can't help thinking will be a prime target when the joint Congressional committee on deficit reduction established by the debt limit bill passed by the House of Representatives last night and by the Senate just a few minutes ago sets up shop this fall.

The unintended consequence that is easily envisioned from this special treatment of EVs is a massive over-investment in a particular and still very expensive vehicle technology, at the expense of other, less costly and more cost-effective technologies. I certainly accept that EVs represent a major long-term trend in cars, but I don't believe that their development requires fiddling with the CAFE rules in this way. Nor is it obvious that US manufacturers enjoy any particular competitive advantage in producing EVs, which depend on ingredients such as rare earths for which we are even more import-dependent than for oil. If saving oil and emissions is what we really care about, then we are entitled to expect that new fuel economy regulations would focus squarely on those outcomes, without being diverted by the industrial policy fad of the moment. Perhaps this will be one of the topics taken up by the House Oversight and Government Reform Committee of the Congress as it investigates the new CAFE rules.

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Carmageddon, Hybrid Cars and Diamond Lanes

The looming "Carmageddon" in Los Angeles made the front page of today's Wall St. Journal, as residents there brace for the two-plus day closure of ten miles of the famed San Diego Freeway (I-405) this weekend. The disruption is apparently required to allow for some demolition necessary for the construction of new high-occupancy vehicle (HOV) lanes on the 405. As locals assess their alternate routes--there are many--they might also want to spend some time thinking about who will be allowed to drive in those new HOV lanes. California recently decided to deny ordinary (non-plug-in) hybrid cars that privilege, in preference to plug-ins and other alternatively fueled vehicles. The new policy and the one it replaces both reflect muddled thinking, but I would argue that abandoning hybrids at this juncture is a mistake, at least if saving gas is still a priority in the Golden State.

I routinely commuted on that stretch of the 405 between the Santa Monica Freeway (I-10) and the Ventura Freeway (US-101) when I lived on the West Side and worked in Mid-Wilshire and later in the San Fernando Valley. I carpooled for part of that time but for most of it, like most other Angelenos, I drove alone. I would have found the option of going solo in the HOV lanes a very appealing way to avoid the frequent stop-and-go traffic, and that's why offering that right to hybrid cars has been a useful non-cash incentive to boost their sales. State officials apparently concluded that normal hybrids are now commonplace, so the incentive should be shifted to the even more efficient cars now becoming available. They have emissions data on their side, because California's electricity mix is dominated by hydropower, nuclear and efficient gas turbines, plus a growing contribution of non-hydro renewables, though it also includes some imported coal-fired power from the Four Corners region. A plug-in should indeed emit less CO2 (directly and indirectly) than a Prius-type hybrid under those conditions.

What I think the state's regulators have missed, however, is that simpler hybrids, which currently enjoy no other incentives, still look like an equally effective way to save gasoline. That's particularly true if most buyers of plug-in cars are choosing them in preference to non-plug-in hybrids, rather than instead of gas-guzzling conventional cars. It comes down to the simple, but often counter-intuitive math of fuel economy the way we calculate it in the US, yielding diminishing gallon savings for increasing miles per gallon (see chart below.) Consider a 50 mpg hybrid that replaces a 25 mpg conventional car. Driven 12,000 miles per year, this choice saves 240 gallons per year. Trading in that hybrid for a plug-in like a Nissan Leaf only saves an additional 240 gallons per year, while a Chevy Volt would save somewhat less than that, unless it were never filled up.



Moreover, plug-ins didn't lack for incentives already. In addition to the federal tax credit of up to $7,500 per car, California offers its own rebate of up to $5,000 for qualifying plug-ins, which also receive discounted rates for electricity. Then there's the money the state is investing in recharging infrastructure. Whether or not the aggregate level of incentives is justified on grounds of economics, environmental and energy security benefits, throwing the HOV benefit on top of them seems like an unnecessary gilding of the lily. The 85,000 hybrids that were given the sticker allowing HOV access for solo drivers still represent a tiny fraction of the state's 39 million registered motor vehicles, and offering 40,000 new stickers for EVs won't make a noticeable dent in California's emissions, or its 40 million gallon-per-day gasoline consumption.

I don't know whether this weekend's Carmageddon will live up to its name, or like L.A.'s 1984 Summer Olympics result in lighter-than-normal traffic because motorists had enough notice to allow them to plan ahead. Yet it does seem that continuing to offer HOV access for non-plug-in hybrids would provide a meaningful incentive for a class of gas-saving vehicles that still represents only around 3% of US car sales, at no cash cost to the state. And if the state is truly concerned that a growing hybrid population could choke the HOV lanes and make them less useful for everyone, an even better option would be to auction the stickers, with only buyers of hybrids, plug-ins and other alternative fuel cars eligible to bid. The proceeds might be sufficient to relieve the state's battered budget of a large portion of the cost of the cash subsidies they're already paying on plug-in cars.

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Justifying $15 Trillion for Renewables

Yesterday I received a joint press release from a group of renewable energy trade associations. It touted a new report from the UN Intergovernmental Panel on Climate Change (IPCC) on the potential growth of renewable energy by 2050. The report has already garnered an impressive array of headlines, such as "Renewable Energy Can Power the World" and "Renewable Energy Key to Solving Climate Change". The headline from the Financial Times was characteristically more concrete, "World faces $15,000 bn renewable energy bill." Unfortunately, although the final report, rumored to run 1,000 pages, might support all of those conclusions when it is issued at the end of the month, the 25-page "Summary for Policymakers" falls far short of inspiring such confidence. Heaven help those policymakers if the summary is all they actually read.

I'm not even sure if "read" is even the correct verb to apply to this document. Once I got beyond the introductory paragraphs it seemed to degenerate into jargon and bureaucratese that was very hard to parse into plain meaning. The report's genesis as the product of pure consensus is readily apparent. Or as Andy Revkin of the New York Times' Dot Earth blog kindly put it, "it doesn't take readers much beyond what is already well established." That's a shame, because we don't need yet another report telling us that we are swimming in enough renewable energy to power our civilization umpteen times over, if we can merely muster the willpower to reach out and tap it. What we urgently need is a roadmap that describes a path--or preferably several possible paths--through the brambles that separate the energy status quo of 2011 from its ideal low-carbon state of 2050.

For example, we need to understand just how renewables will supplant the petroleum that currently provides around 94% of all transportation energy, at least in the US. That demand might be met by biofuels, although the report points out that the first-generation biofuels that supply nearly 3% of global road transport fuel today, but are still the only kind available on a commercial scale, have serious shortcomings. Closing the gap between 3% and 94% would require a true revolution in next-generation biofuels from sources such as cellulose and algae, yet after reading the Summary for Policymakers we are no wiser about when and how this will occur. I might note that such developments are rarely amenable to precise timetables, as the EPA is learning to its chagrin.

Alternatively, or in combination with biofuels, renewables might replace petroleum in transportation via the potentially more robust pathway of vehicle electrification, matching improved batteries with rapidly expanding supplies of intermittent renewables (wind, solar, tidal, etc.) delivered via increasingly intelligent power grids. But if that's the scenario, its crucial details are barely hinted at here.

The basic message of the summary appears to be that with enough investment, supported by the right policies, the currently identified renewable energy sources could expand by enough that in the very best case (out of 164 scenarios they considered) they could supply roughly as much energy by mid-century as we currently get from fossil fuels. That corresponds to 77% of total expected energy consumption in 2050 and may be the source of the headlines I saw. Of course the median level of those 164 scenarios is quite a bit lower, and the determination of the share of renewables in total energy relies on a projection implying that total global energy consumption will grow by an average of just 0.25% per year over the next 40 years. That suggests either a massive energy efficiency effort or minimal further economic uplift in the developing world. On a more reasonable track of 1% annual energy growth, the top scenario in the scatter chart on page 19 would meet 58% of total 2050 demand, while the median result would cover just a third of global energy needs. That's still impressive, compared to where we are today, but not quite as headline-grabbing.

I will be keenly interested to see what sort of scenarios the IPCC looked at in putting together the report on which this summary is based. Something tells me that they are likelier to fall into the category of what I would call projections or "cases" than true scenarios, which dig deeply into underlying trends and uncertainties and are not merely the output of a mechanistic model. That's not just a technical quibble, because I'm not aware of a single model-type forecast from 1970 that accurately projected the economic and sociopolitical conditions in which we find ourselves today. The intervening improvements in computing power and econometric sophistication still seem insufficient to conquer the fundamental unpredictability of looking that far into the future. But then the IPCC has a built-in bias to accept the results of such work, since long-term climate models underpin its entire effort. I hope I'm not alone in thinking that the expenditure of up to $15 trillion requires a much more rigorous justification than anything provided in this document. Whether or not Saint-Exupery really said it, a goal without a plan is just a wish.

If it seems that I'm being overly critical of a 1,000 page report that I haven't even seen on the basis of the horse-by-committee summary that I have seen, I plead guilty. But isn't that the same sin that the journalists and industry spokespeople are committing when they use this summary as the basis of glowing claims about the potential of renewables? And then there are the politicians and bureaucrats who will attempt to commit vast sums without ever reading any more than summaries such as this--at best--and without questioning the host of assumptions that went into them. If anything, this Summary for Policymakers reinforces my concern that the UN climate process has become so unwieldy and unresponsive that we must look elsewhere for leadership on this complex challenge. Meanwhile, we deserve a clearer articulation of how renewables can overcome the considerable obstacles that stand between their recent impressive performance and the achievement of the milestones this report suggests lie ahead.

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The Future Energy Station Arrives

I was very interested to read that Valero, the largest independent refiner in the US, is designing its new gas stations to offer a much wider variety of energy products, including natural gas, E85 ethanol, and potentially recharging facilities for electric vehicles. This is an announcement I've been expecting for more than ten years, and there are good reasons why other companies are likely to follow. At the same time, the economics of doing this now, when the market for non-petroleum fuels is still comparatively small, look challenging. Some will call this a vanity project, and they won't be entirely wrong, even if it also represents the template for the new retail energy facilities that will be built in the next several decades.

Valero's new station design, at least as described in the articles I've seen, embodies the result of trends that my former company, Texaco Inc., identified in the late 1990s in a scenario called Multiple Choice Energy. That view included a combination of new vehicle technologies such as hybrids, EVs and fuel cells, as well as a vision of the retail network that would meet their needs. As attractive as the idea was to many of the top executives to which our team presented, it was a tough sell, because retail fuel is such a difficult business. Margins are slim, competition high, and major redesigns of existing facilities--for rebranding or any other purpose--very hard to justify financially. Several companies have dabbled with elements of this vision, including my former employer, but I'm not aware of anyone deploying the full suite of options in one location.

I think this development, and the company pushing it, is significant for several reasons. First, Valero has already made a major commitment to non-petroleum fuels through its acquisition of ten ethanol plants, bought during a period when the US ethanol industry was being squeezed by poor margins and scarce credit. Those facilities contributed 18% of Valero's operating income in the first quarter of this year, even though they accounted for less than 4% of total output by volume. Adding E85, a blend of 85% ethanol and 15% gasoline, at the company's new stations merely completes a supply chain in which it is already well-established.

Incorporating these capabilities when a station is built, rather than adding them later, is also crucial. It saves a significant amount of money by avoiding the business disruption involved in retrofitting later. E85 faces other challenges, as I discussed recently, but this kind of planning overcomes one of the major impediments to its wider penetration in the US market, which already has millions of flexible fuel vehicles capable of running on it. And for this reason it's especially notable that this initiative is being taken by Valero, which has been expanding its retail network and investing in new sites. That's in contrast to the major oil companies, some of which have been exiting retail, either gradually or on an area-by-area basis, to free up capital for more profitable opportunities in exploration and production.

Adding natural gas and electricity to the array of fuels sold at retail sites is a natural evolution of this strategy but financially much riskier, given the small number of EVs and NGVs on the road so far. Although the company can take advantage of generous tax credits for installing some of these capabilities, the return is likely to be low for some time. EV recharging also requires a large footprint and extra caution, to ensure that it can be done safely in proximity to combustible fuels. Local agencies and fire marshals have definite ideas about this, as I learned when I was involved in plans for recharging facilities for GM's earlier EV-1 plug-in vehicle in the late '90s.

As with the market penetration of the alternative fuel vehicles they will serve, it will be some time before most retail stations offer quite as much choice as Valero's new multi-fuel facility. It takes time to roll out such changes, and the infrastructure can't get too far ahead of the demand for it without its owners going bankrupt in the process. Nor will every new fuel succeed. Methanol blends looked like the next big thing in the 1980s, but they never took off. Still, it wouldn't take many such facilities in each market to break the "chicken-and-egg" barrier that any non-petroleum transportation energy alternative faces. The success of this initiative depends on the demand for these fuels actually materializing. Launching when the average US gasoline price is just a couple of cents below $4.00 looks like good timing to me.

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Obama on Energy: Getting the Balance Right

Another energy crisis, another presidential speech? It must seem that way to many of us who came of age in the first set of energy crises in the 1970s, and the President acknowledged that history in his talk on energy at Georgetown University on Wednesday. Yet although it contained little in the way of new ideas or initiatives, along with a target that was remarkable mainly for the relative ease with which it might be met, it at least presented a perspective that balances the continuing importance of our current energy sources with the potential of our new ones. No more talk of "yesterday's energy."

I was under the weather this week, so this is at least a day later than it should be, but if nothing else was clear from Wednesday's speech it's that our energy challenges have persisted for so long, while our preferred solutions have shifted with the mood of the moment, that a day or a week changes nothing. However, a sense of urgency matters, as gasoline prices rise to levels we haven't seen since 2008. A president can't be seen to be behind the curve on this issue. Except for a few quibbles I'll come back to, Mr. Obama got matters mostly right, reminding his audience that we will remain dependent on oil for a long time, and that increasing domestic oil production and relying on stable neighbors are both crucial strategies for managing our vulnerability to imports from less dependable sources. That puts him squarely in the mainstream of serious American energy thinking for the last four decades.

The President's goal of reducing oil imports by one-third from their level of 11 million barrels per day in 2008 seemed appropriate for several reasons. First, because the basis of that goal is the right one: net imports of crude oil and petroleum products. It would do little for our energy security to reduce crude imports by constraining US refineries and then importing more refined products from abroad. Nor should one ignore the growing US exports of refined products arising from mismatches between US fuel regulations and refinery configurations and yields. More importantly, this is one of the first energy security goals I've seen that we stand a fair chance of achieving. The DOE's preliminary forecast for 2011-35 shows a 17% reduction in oil imports by 2025 in the reference, or base case. Last year's forecast for the high oil price case showed an even steeper reduction, meeting Mr. Obama's goal as early as 2021. Reaching the President's target shouldn't require Herculean efforts, provided we stay focused on the things with the greatest potential to deliver in that timeframe: increased domestic production, efficiency, and possibly next-generation biofuels. That leaves out electric vehicles, which are a longer-term proposition, along with wind, solar and other renewable electricity sources, which only stand to displace oil via EVs. (Remember, a million EVs replace less than 0.2% of our oil consumption.)

The President was right to highlight the potential contribution from biofuels while calling for reform in biofuel subsidies, a task that is long overdue. He cited two examples of how biofuels could help to reduce our oil imports. One related to the military's goal of obtaining half its domestic jet fuel needs from alternatives to petroleum, while the other promoted four "next-generation biorefineries", referring to facilities that produce fuel from non-food biomass. Unfortunately, he didn't mention cost as one of the key trade-offs involved. It's laudable for the military to seek to reduce its vulnerability to oil-supply disruptions, and it can provide a crucial early-adopter base for new technologies. However, to the extent that bio-based jet fuel is more expensive than conventional fuel, then either Air Force operating budgets must include cuts in other areas, such as missions and training, or we will be buying fewer new-gen aircraft to pay for it. And while subsidies can help next-gen biofuels reach commercial scale--I don't consider 20 million gallons per year (1,300 bbl/day) as meeting that definition--they can't guarantee they will be commercial. That will require mastery of one or more of the numerous technology paths now being pursued, more than a few of which have already disappointed. Technological mastery doesn't appear on command.

That's an important consideration, because as desirable as it is to produce large quantities of biofuel without setting up ruinous competition between food and fuel, it seems equally important not to build another industry that will be unprofitable without sustained large government subsidies for decades to come. Helping new technologies through the development stage and across the "commercialization chasm" makes sense, but the level of support now offered for cellulosic biofuel, at $1.01/gal., looks unaffordable once output finally start to take off. As it is, corn-based ethanol will collect roughly $6.3 billion this year from a subsidy less than half that generous, for its displacement of just under 7% of our gasoline consumption on an energy-equivalent basis.

That brings us to the only item in Wednesday's talk that we haven't been hearing about for years: the application of the nation's newly-tapped shale gas bonanza to address the problem of our oil imports. Aside from the jokey references to the expertise of his Secretary of Energy, whose Nobel Prize in Physics was for "development of methods to cool and trap atoms with laser light"--not so relevant to natural gas extraction--this was the speech's money line. Shale gas is the only new technology we have that can deliver huge amounts of energy to compete directly with oil in transportation using off-the-shelf-technology: no breakthroughs required. This would have sounded even more impressive and serious if the punch line had focused on knocking down the barriers to making that happen, including infrastructure requirements and vehicle conversion costs, rather than calling for a bill regulating the production of shale gas.

And unfortunately, that was symptomatic of the things that kept the President's talk from being a landmark in our decades-long battle with energy security. It's one thing to state the problem clearly and lay out the options; it's another to bring it all together in a realistic plan for action. The administration's new "Blueprint for a Secure Energy Future" merely incorporates natural gas into a grab bag of many of the same initiatives it has been pushing since Inauguration Day 2009. Nor does it help when the President repeats his old talking point about the US consuming 25% of the world's oil (it was actually 22% last year) but having only 2% of its oil reserves. Someone needs to pull him aside and explain that current US proved reserves are no more of a limitation on future US oil production than wind power's contribution of just 2% of US power generation last year caps its future potential at that level. Reserves support today's production; resources determine tomorrow's, and the US has many billions of barrels of untapped resources, many of which remain off limits under the administration's policies.

So call it two-thirds of a great speech on energy. Unfortunately, what we desperately need is that missing third that concentrates it into something that the American people--and American industry--can rally behind.

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Libya's Ripples for Energy Markets

The unrest that began in Tunisia and Egypt has now destabilized a country that exports important quantities of petroleum, and the oil market is reacting in earnest. With Libya in violent turmoil, UK Brent crude traded above $108 per barrel today, and even West Texas Intermediate (WTI), which has been massively discounted due to excessive inventory at its Cushing, OK delivery point, hit $98 in early trading before falling back to the mid-$90s. Unless events in Libya resolve quickly and positively, oil's price moves will shortly translate into higher gasoline prices. As I considered these events over breakfast, it also struck me that GM and Nissan could turn out to be very lucky indeed in launching their electric vehicles now, instead of a year or two ago when gas prices were lower and less volatile.

The media commentary I've seen so far concerning Libya's oil production has missed some key details that explain why a disruption of exports that in theory can be covered by OPEC's ample spare capacity--currently at a multiple of Libya's output--could be disproportionately large. Instead of focusing on Libya having Africa's largest oil reserves--a fact that is important for the long run but essentially irrelevant in the current situation--what matters is production and exports, and especially the location and quality of the latter. Libya produces around 1.7 million bbl/day of crude oil and exports much of that, due to its small domestic market. As oil companies evacuate personnel, that output will drop, and exports from Libya's ports are at risk of disruption by the chaos unfolding there. The majority of those exports stay in the Mediterranean, where they are key inputs for Italian, French and Spanish refiners. Very little of it comes to the US, for which Libyan oil made up less than 1% of our imports in 2009. So any effect on US markets will be indirect, but no less dramatic for that.

On the surface, OPEC is more than capable of making up for the loss of a bit over 1 million bbl/day from the market, if it wished. However, most of the cartel's roughly 5 million bbl/day spare capacity is on the Arabian peninsula--near another focus of instability in Bahrain, which is no longer an oil exporter. Nor is most of OPEC's remaining capacity of a quality comparable to the typically light, sweet crude types that constitute most of Libya's output. These crudes are well-suited for making the diesel favored in Europe, and it would be difficult for many European refiners to switch on short notice to a diet richer in Saudi grades that are higher in sulfur.

Various analysts have noted that US gas prices were already reflecting higher world oil prices, rather than the lagging WTI indicator. With April gasoline futures trading above $2.75/gal. on the NYMEX this morning, that would yield an effective average US retail unleaded regular price of around $3.45/gal, after factoring in excise and sales taxes and typical dealer margin. That's well above the $3.18/gal. average that the Lundberg Survey reported for last week. It would also be the highest average at the pump since October 2008, when prices were unraveling from their $4-plus peak of that summer.

It's too soon to predict an imminent return to those heights, although no one can gauge what will happen next in Libya, where it's not even clear who's in charge at the moment. (It does seem safe to predict that the US will not lead a NATO invasion of Libya, as Fidel Castro has apparently warned.) Still, it is worth thinking about how consumers might react if the current chaos persisted. The last time gas prices rose sharply, we saw significant drops in both US vehicle miles traveled and gasoline consumption. We also observed a noticeable increase in the sales of hybrid cars, which have lagged recently. There were no mass-market electric vehicles available at the time, but it doesn't require a leap of faith to envision a healthy boost in EV sales from their low initial levels, too. That would be good for both GM and Nissan, which have invested enormous sums--and their corporate reputations--bringing their Volt and Leaf models to market. It might not be so positive for sales of clean diesels, despite their high efficiency, if constraints on Libyan oil tighten European diesel supplies and drive up world diesel prices.

Events in North Africa and the Middle East will determine how high oil and gasoline prices rise in the weeks ahead. If Libya's dictator departs as readily as President Mubarak did, things could settle down quickly, unless the unrest spreads to another major oil producer. It's still too early to call this a new oil crisis, but it's not too soon to consider our options if it proved to be one. Although that would be a very unwelcome shock to an economy just regaining some momentum, we have many more options than in 1979, when the Iranian Revolution sent oil prices to levels that it took nearly three decades to exceed, in real terms.

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